UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
   FORM 10-Q    x
QUARTERLY
  REPORT UNDER SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934For
  the quarterly period ended September 30, 2006TRANSITION
  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from
  _________ to _________Commission file number 1-14762   THE SERVICEMASTER COMPANY
(Exact name of
registrant as specified in its charter)    Delaware

36-3858106(State
  or other jurisdiction of

(IRS
  Employer Identification No.)incorporation or organization)3250 Lacey Road, Ste. 600, Downers
  Grove, Illinois¡60515-1700(Address of principal executive
  offices)                       (Zip Code)630-663-2000(Registrants telephone number,
  including area code) Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes x   No o Indicate by check mark whether the Registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of accelerated filer and
large accelerated filer in Exchange Act Rule 12b-2. Large accelerated filer x
Accelerated filer o
Non-accelerated filer o Indicate by check mark whether the registrant is a
shell company (as defined in Exchange Act Rule 12b-2). Yes o   No x Indicate the number of shares outstanding of each of
the issuers classes of common stock: 287,000,000 shares of common stock on
October 31, 2006.    TABLE OF
CONTENTS

Page 
  No.THE SERVICEMASTER COMPANY (Registrant) -Part
  I. Financial InformationItem 1:
  Financial Statements (Unaudited)Condensed
  Consolidated Statements of Operations for the three and nine months ended
  September 30, 2006 and September 30, 2005

3Condensed
  Consolidated Statements of Financial Position  as of September 30, 2006 and December 31, 2005

4Condensed
  Consolidated Statements of Cash Flows for the nine months ended September 30,
  2006 and September 30, 2005

5Notes
  to Condensed Consolidated Financial Statements

6Item
  2: Management Discussion and Analysis of Financial  Condition and Results of Operations

19Item
  3: Quantitative and Qualitative Disclosures About Market Risk

32Item
  4: Controls and Procedures

33Part
  II. Other InformationItem
  1: Legal Proceedings

34Item
  1A: Risk Factors

34Item
  2: Unregistered Sales of Equity Securities and Use of Proceeds

35Item
  6:  Exhibits

35Signature

362

PART
I. FINANCIAL INFORMATION
THE SERVICEMASTER COMPANYCondensed Consolidated Statements of Operations (Unaudited)(In thousands, except per share data)

Three Months Ended

Nine Months EndedSeptember 30,

September 30,2006

2005

2006

2005Operating
Revenue

$
971,436

$
925,492

$
2,658,447

$
2,519,879Operating
Costs and Expenses:Cost of
services rendered and products sold


599,102


562,919


1,645,634


1,547,114Selling and
administrative expenses


258,235


237,284


717,111


681,652Amortization
expense


3,116


1,443


8,526


3,926Restructuring
charges


855





10,693


Total
operating costs and expenses


861,308


801,646


2,381,964


2,232,692Operating
Income


110,128


123,846


276,483


287,187Non-operating
Expense (Income):Interest
expense


16,081


13,749


46,604


43,729Interest and
investment income, net


(7,136
)

(5,516
)

(18,685
)

(18,116
)Minority
interest and other expense, net


2,066


2,080


6,189


6,173Income from
Continuing Operations before Income Taxes


99,117


113,533


242,375


255,401Provision for
income taxes


37,619


43,361


93,920


98,802Income from
Continuing Operations


61,498


70,172


148,455


156,599Income (loss)
from discontinued operations, net
  of income taxes


6,472


11,415


(17,652
)

15,361Net
Income

$
67,970

$
81,587

$
130,803

$
171,960Per
Share:Basic Earnings
Per Share:Income from
continuing operations

$
0.21

$
0.24

$
0.51

$
0.54Income (loss)
from discontinued operations


0.02


0.04


(0.06
)

0.05Basic earnings
per share

$
0.24

$
0.28

$
0.45

$
0.59Shares


288,826


291,474


290,364


291,426Diluted
Earnings Per Share:Income from
continuing operations

$
0.21

$
0.23

$
0.51

$
0.52Income (loss)
from discontinued operations


0.02


0.04


(0.06
)

0.05Diluted
earnings per share

$
0.23

$
0.27

$
0.45

$
0.57Shares


297,493


305,239


300,000


305,250See Notes to
Condensed Consolidated Financial Statements

3

THE
SERVICEMASTER COMPANYCondensed
Consolidated Statements of Financial Position (Unaudited)(In thousands, except per
share data)

As of September 30,

As of December 31,2006

2005AssetsCurrent
Assets:Cash and cash
equivalents

$
223,960

$
114,508Marketable
securities


109,261


104,807Receivables,
less allowance of $23,124 and
  $17,702, respectively


469,208


309,567Inventories


69,721


60,331Prepaid
expenses and other assets


38,943


23,948Deferred
customer acquisition costs


43,329


40,402Deferred
taxes


25,929


35,050Assets of
discontinued operations


4,896


135,100Total Current
Assets


985,247


823,713Property and
Equipment:At
cost


413,966


364,503Less:
accumulated depreciation


(239,904
)

(202,676
)Net property
and equipment


174,062


161,827Other
Assets:Goodwill


1,618,005


1,548,070Intangible
assets, primarily trade names, net


246,978


230,343Notes
receivable


29,036


30,941Long-term
marketable securities


160,325


147,332Other
assets


38,668


9,304Assets of
discontinued operations





77,340Total
Assets

$
3,252,321

$
3,028,870Liabilities
  and Shareholders EquityCurrent
Liabilities:Accounts
payable

$
110,066

$
91,625Accrued
liabilities:Payroll and
related expenses


98,515


103,028Self-insured
claims and related expenses


91,008


93,047Income taxes
payable


45,838


30,730Other


94,345


87,984Deferred
revenues


444,426


432,741Liabilities of
discontinued operations


13,607


97,294Current
portion of long-term debt


20,689


19,222Total Current
Liabilities


918,494


955,671Long-Term
Debt


852,676


638,928Long-Term
Liabilities:Deferred
taxes


166,234


113,300Liabilities of
discontinued operations


8,269


10,130Other
long-term obligations


164,143


156,201Total
Long-Term Liabilities


338,646


279,631Minority
Interest


100,000


100,000Commitments
  and ContingenciesShareholders Equity:Common stock
$0.01 par value, authorized
  1,000,000 shares; issued   323,103 and 321,338 shares, respectively


3,231


3,213Additional
paid-in capital


1,134,126


1,117,388Retained
earnings


314,987


282,993Accumulated
other comprehensive income


6,345


7,197Restricted
stock (unearned compensation)





(14,438
)Treasury
stock


(416,184
)

(341,713
)Total
Shareholders Equity


1,042,505


1,054,640Total
Liabilities and Shareholders Equity

$
3,252,321

$
3,028,870See
Notes to Condensed Consolidated Financial Statements

4

THE SERVICEMASTER COMPANYCondensed Consolidated Statements of Cash Flows (Unaudited)(In thousands)

Nine Months Ended
  September 30,2006

2005Cash and Cash Equivalents at January 1

$
114,508

$
256,626Cash Flows from Operating
  Activities from Continuing Operations:Net Income


130,803


171,960Adjustments to
reconcile net income to net cash
  provided from operating activities:Loss (income)
from discontinued operations


17,652


(15,361
)Depreciation
expense


34,981


33,099Amortization
expense


8,526


3,926Change in working capital, net
of acquisitions:Receivables


(103,363
)

(86,972
)Inventories
and other current assets


(24,250
)

(25,409
)Accounts
payable


13,163


31,194Deferred
revenues


4,701


(1,644
)Accrued
liabilities


(11,300
)

24,400Change in tax
accounts:Current and
deferred income taxes


78,099


93,459Resolution of
income tax audits


(4,907
)

(131,146
)Other,
net


12,232


8,862Net Cash Provided from
  Operating Activities from Continuing Operations


156,337


106,368Cash Flows from Investing
  Activities from Continuing Operations:Property
additions


(38,107
)

(32,722
)Sale of
equipment and other assets


1,389


2,044Business
acquisitions, net of cash acquired


(134,465
)

(27,342
)Notes
receivable, financial investments and
  securities


(13,529
)

(13,492
)Net Cash Used for Investing
  Activities from Continuing Operations


(184,712
)

(71,512
)Cash Flows from Financing
  Activities from Continuing Operations:Borrowings of
debt


1,038,151


108,299Payments of
debt


(836,965
)

(157,371
)Purchase of
ServiceMaster stock


(86,053
)

(51,305
)Shareholders dividends


(98,809
)

(96,118
)Proceeds from
employee share plans


23,327


25,040Net Cash Provided from (Used
for) Financing
  Activities from Continuing Operations


39,651


(171,455
)Cash Flows from Discontinued
  Operations:Cash provided
from (used for) operating
  activities


(13,415
)

5,167Cash provided
from (used for) investing
  activities, including proceeds from sale of businesses


111,591


(2,548
)Net Cash Provided from
  Discontinued Operations


98,176


2,619Cash Increase (Decrease)
During
  the Period


109,452


(133,980
)Cash and Cash Equivalents at
  September 30

$
223,960

$
122,646See Notes to Condensed Consolidated Financial
Statements

5

THE SERVICEMASTER COMPANYNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note 1: The condensed consolidated
financial statements include the accounts of The ServiceMaster Company and its
subsidiaries, collectively referred to as the Company. Intercompany
transactions and balances have been eliminated in consolidation. The financial
results as well as the assets and liabilities related to American Residential Services
and American Mechanical Services have been classified as discontinued
operations in all periods.

Note 2: The condensed consolidated
financial statements have been prepared by the Company in accordance with
accounting principles generally accepted in the United States (GAAP) and
pursuant to the rules and regulations of the Securities and Exchange
Commission. The Company recommends that the quarterly condensed consolidated
financial statements be read in conjunction with the consolidated financial statements
and the notes thereto included in the Companys latest Annual Report to
Shareholders incorporated in the Form 10-K filed with the Securities and
Exchange Commission for the year ended December 31, 2005 (2005 Annual Report).
The condensed consolidated financial statements reflect all adjustments which
are, in the opinion of management, necessary for the fair presentation of the
financial position, results of operations and cash flows for the interim
periods. The results of operations for any interim period are not necessarily
indicative of the results which might be achieved for a full year.

Note 3: The Company has identified the most
important accounting policies with respect to its financial position and
results of operations. These relate primarily to revenue recognition and the
deferral of customer acquisition costs. The following revenue recognition
policies have not changed since year-end, although the policy discussed below
related to revenue from commercial disaster response and reconstruction projects
has been added as a result of the acquisition in February 2006 of InStar
Services Group (InStar). Revenues from lawn care and pest control services and
liquid and fumigation termite applications are recognized as the services are
provided. Revenues from landscaping services are recognized as they are earned
based upon agreed monthly contract arrangements or when services are performed
for non-contractual arrangements. The Company eradicates termites through the
use of baiting systems, as well as through non-baiting methods (e.g.,
fumigation or liquid treatments). Termite eradication services using baiting
systems, as well as home warranty services, frequently are sold through annual
contracts for a one-time, upfront payment. Direct costs of these contracts
(service costs for termite contracts and claim costs for warranty contracts)
are expensed as incurred. The Company recognizes revenue over the life of these
contracts in proportion to the expected direct costs. Those costs bear a direct
relationship to the fulfillment of the Companys obligations under the
contracts and are representative of the relative value provided to the customer
(i.e., the proportional performance method). Home warranty contract revenue is
recognized based on the expected emergence of total claim costs. The Company
regularly reviews its estimates of direct costs for its termite bait and home
warranty contracts and adjusts the estimates when appropriate. Revenue from the
Companys commercial disaster response and reconstruction projects are
recognized using the percentage of completion method in the ratio that total
incurred costs bear to total estimated costs. The Company has franchise
agreements in its TruGreen ChemLawn, Terminix, ServiceMaster Clean, Merry
Maids, AmeriSpec and Furniture Medic businesses. Franchised revenue (which in
the aggregate represents approximately three percent of consolidated revenue)
consists principally of monthly fees based upon the franchisees customer level
revenue. Monthly fee revenue is recognized when the related customer level
revenue is reported by the franchisee and collectibility is assured. Franchise
revenue also includes initial fees resulting from the sale of a franchise.
These fees are fixed and are recognized as revenue when collectibility is
assured and all material services or conditions relating to the sale have been
substantially performed. Total profits from the franchised operations comprised
10 percent and eight percent of the consolidated operating income, before
headquarter overhead and restructuring charges, for the three months ended
September 30, 2006 and 2005, respectively. In addition, these franchised
profits comprised 10 percent of the consolidated operating income, before
headquarter overhead and restructuring charges, for the nine months ended
September 30, 2006 and 2005. The portion of total franchise fee income related
to initial fees received

6

from the sale
of a franchise was immaterial to the Companys consolidated financial
statements for all periods.

The Company
had $444 million and $433 million of deferred revenue at September 30, 2006 and
December 31, 2005, respectively, which consist primarily of payments received
for annual contracts relating to home warranty, termite baiting, pest control
and lawn care services. The revenue related to these services is recognized
over the contractual period as the direct costs emerge, such as when the
services are performed or claims are incurred.

Customer
acquisition costs, which are incremental and direct costs of obtaining a
customer, are deferred and amortized over the life of the related contract in
proportion to revenue recognized. These costs include sales commissions and
direct selling costs which can be shown to have resulted in a successful sale.

TruGreen
ChemLawn has significant seasonality in its business. In the winter and early
spring, this business sells a series of lawn applications to customers which
are rendered primarily in March through October (the production season). This
business incurs incremental selling expenses at the beginning of the year that
directly relate to successful sales for which the revenues are recognized in
later quarters. On an interim basis, TruGreen ChemLawn defers these incremental
selling expenses, pre-season advertising costs and annual repairs and
maintenance procedures that are performed primarily in the first quarter. These
costs are deferred and recognized in proportion to the contract revenue over
the production season, and are not deferred beyond the calendar year-end. Other
business segments of the Company also defer, on an interim basis, advertising
costs incurred early in the year. These costs are deferred and recognized
approximately in proportion to revenue over the balance of the year, and are
not deferred beyond the calendar year-end.

The cost of
direct-response advertising at Terminix and TruGreen ChemLawn, consisting
primarily of direct-mail promotions, is capitalized and amortized over its
expected period of future benefits.

The
preparation of the financial statements requires management to make certain
estimates and assumptions required under GAAP which may differ materially from
the actual results. Disclosures in the 2005 Annual Report presented the
significant areas that require the use of managements estimates and discussed
how management formed its judgments. The areas discussed included the allowance
for uncollectible receivables; accruals for self-insured retention limits
related to medical, workers compensation, auto and general liability insurance
claims; accruals for home warranty and termite damage claims; the possible
outcome of outstanding litigation; income tax liabilities and deferred tax
accounts; useful lives for depreciation and amortization expense; and the
valuation of tangible and intangible assets. There have been no changes
in the significant areas that require estimates or in the underlying
methodologies used in determining the amounts of these associated estimates,
other  than  the area of  work-in-process  for
commercial disaster response and reconstruction projects which has been added as
a result of the February 2006 acquisition of InStar. The estimated percentage of
completion on a particular project is based on several factors including the
contract value, the total expected costs to complete the project, historical
returns and margins on comparable projects, and the mix and type of labor and
equipment required to complete the project.

Note 4: The Company carries insurance
policies on insurable risks at levels which it believes to be appropriate,
including workers compensation, auto and general liability risks. The Company
has self-insured retention limits and insured layers of excess insurance
coverage above those limits. Accruals for self-insurance losses and warranty
claims in the American Home Shield business are made based on the Companys
claims experience and actuarial projections. Current activity could differ
causing a change in estimates. The Company has certain liabilities with respect
to existing or potential claims, lawsuits, and other proceedings. The Company
accrues for these liabilities when it is probable that future costs will be
incurred and such costs can be reasonably estimated. Any resulting
adjustments, which could be material, are recorded in the period the
adjustments are identified.

Note 5: The
Company has implemented certain organizational changes focused on increasing
the speed and intensity of executing its strategic initiatives and accelerating
the growth of the Company. In the second quarter, Jonathan P. Ward resigned as
Chairman and Chief Executive Officer of the Company and the Company appointed
J. Patrick Spainhour to serve as Chairman and Chief Executive Officer. In

7

addition, earlier this year
the Company launched Project Accelerate, an internal, multi-phase restructuring
project designed to improve the effectiveness and efficiency of all functional
support areas.

Related to these
organizational changes, the Company recorded restructuring charges of $0.9
million in the third quarter of 2006 and $10.7 million for the nine months
ended September 30, 2006. The nine month charges included severance ($4.4
million for the former Chief Executive Officer and $3.2 million for other
individuals) and third-party professional fees and expenses ($3.1 million)
directly related to implementing the organizational changes. These charges are
reported in the Restructuring charges line in the Consolidated Statements of
Operations and were recorded in the Other Operations and Headquarters business
segment.

On October 30, 2006, The
ServiceMaster Company announced a plan to consolidate its corporate
headquarters into its operations center in Memphis, Tennessee and close its
current headquarters in Downers Grove, Illinois. The transition to Memphis is
targeted to be completed by July 2007. The Board of Directors of the Company
approved the action on October 27, 2006.

The Companys operating business
units and leadership are already headquartered in Memphis and currently employ over 2,300
individuals. A number of company-wide support functions are also already located there,
and are included in that employment total. The Downers Grove, Illinois office currently
employs approximately 170 individuals, virtually all of which will be impacted by the
decision to consolidate headquarters. The Downers Grove functions affected by the
consolidation include corporate accounting, treasury and finance, tax, and portions of the
legal, information technology, marketing, and mergers and acquisitions functions. The
Company believes the consolidation of Downers Grove support functions and positions with
operating unit leadership in Memphis will improve the speed and effectiveness of
communications and decision-making. The relocation to Memphis is targeted to be completed
by July 2007.

In connection with the
consolidation plan, the Company expects to incur incremental costs in the range
of $25 to $30 million over the next nine months. Such costs include employee
retention and severance costs of approximately $16 to $19 million, lease
termination costs of approximately $5 million, and employee relocation,
recruiting and training costs of approximately $4 to $6 million. Almost all
such costs will be cash expenditures. In accordance with GAAP, the Company expects to recognize approximately
$10 million of these charges in the fourth quarter of 2006, with the remaining
charges being recognized in fiscal 2007.

In addition to the charges
noted above, the Company expects to incur certain other cash charges throughout
the consolidation process. These additional charges include training of
replacement employees, the costs related to headcount overlap during a
transitional training period, and temporary employee staffing, should the need
arise. While the estimate of these costs, in total, is not yet final, the
Company currently expects that it will incur approximately $3 million of pre-tax
costs during the first half of 2007 related to these factors.

In connection with the
consolidation, the Company expects to realize reductions in travel and rent
costs of approximately $3 to $4 million per year, with full realization of
these annual savings beginning in 2008. Additionally, savings are expected to
be realized from State and Local tax incentives, the net present value of which
is comparable to the costs of the consolidation. These incentives are expected
to be realized over a period of 8 to 20 years, depending on their type.

Note 6: In accordance with Statement of Financial Accounting
Standards (SFAS)
No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets
that are not amortized are subject to assessment for impairment by applying a
fair-value based test on an annual basis or more frequently if circumstances
indicate a potential impairment. Such circumstances could include actual
earnings being significantly below managements estimates. The Companys annual
assessment date is October 1.

On February 28, 2006, the Company acquired InStar, a leading
provider of commercial disaster response and reconstruction services for
approximately $85 million in cash. The results of InStars operations have been
included in the Companys consolidated financial statements since the
acquisition date. The purchase price was allocated to the underlying net assets
acquired, consisting primarily of trade receivables, project costs in excess of
billings and accounts payable and accrued expenses. In addition, the Company
allocated $20 million to customer relationships, project backlog and other
intangible assets that have a weighted-average useful life of approximately
five years. The Company recorded $33 million of goodwill. None of the goodwill,
customer relationships project backlog or other intangible assets is expected
to be deductible for tax purposes. In determining this preliminary allocation
of purchase price, the Company utilized the services of third-party valuation
experts. The allocation of purchase price is substantially complete. Pending
receipt of additional information regarding the fair value of certain
pre-acquisition contingencies, the Company expects to finalize the purchase
price

8

allocation by the end of the first quarter of 2007. The remaining
increase in goodwill and intangible assets relates to tuck-in acquisitions
completed throughout the first nine months primarily by Terminix and TruGreen
ChemLawn.

The table
below summarizes the goodwill and intangible asset activity and balances:

(In thousands)


As of







As ofDecember 31,





September
  30,2005

Additions

Amortization

2006Non-amortizable
  Assets:Goodwill

$
1,548,070

$
69,935

$


$
1,618,005Trade names & other


215,493








215,493Amortizable
  Assets:Other intangible assets


49,981


25,161





75,142Accumulated amortization(1)


(35,131
)




(8,526
)

(43,657
)Net other intangibles


14,850


25,161


(8,526
)

31,485Total

$
1,778,413

$
95,096

$
(8,526
)
$
1,864,983(1) Expected amortization
expense for 2006 of approximately $11 million is expected to decline by $1.7 million
annually over the next five years.

The table below presents, by segment, the goodwill that is not subject
to amortization:

(In thousands)

As of

As ofSeptember 30,

December 31,2006

2005TruGreen ChemLawn

$
726,899

$
700,029Terminix


668,564


661,166American Home Shield


85,378


85,526Other Operations & Headquarters


137,164


101,349Total

$
1,618,005

$
1,548,070Note 7: Basic
earnings per share are computed by dividing income available to common stockholders
by the weighted-average number of shares outstanding for the period. The
weighted-average common shares for the diluted earnings per share calculation
includes the incremental effect related to outstanding options and stock
appreciation rights (SARS) whose market price is in excess of the grant price.
Shares potentially issuable under convertible securities have been considered
outstanding for purposes of the diluted earnings per share calculations. In
computing diluted earnings per share, the after-tax interest expense related to
convertible securities is added back to net income in the numerator, while the
diluted shares in the denominator include the shares issuable upon conversion
of the securities.

The following
table reconciles both the numerator and the denominator of the basic earnings
per share from continuing operations computation to the numerator and the
denominator of the diluted earnings per share from continuing operations
computation.

(In thousands, except per share data)

Three Months

Three MonthsEnded Sept. 30, 2006

Ended Sept. 30, 2005Continuing Operations:

Income

Shares

EPS

Income

Shares

EPSBasic earnings
per share

$
61,498


288,826

$
0.21

$
70,172


291,474

$
0.24Effect of
dilutive securities,
  net of tax:Options &
SARS





667








5,765Convertible
securities


1,241


8,000





1,178


8,000Diluted
earnings per share

$
62,739


297,493

$
0.21

$
71,350


305,239

$
0.239

(In thousands, except per share data)

Nine Months

Nine MonthsEnded Sept. 30, 2006

Ended Sept. 30, 2005Continuing Operations:

Income

Shares

EPS

Income

Shares

EPSBasic earnings
per share

$
148,455


290,364

$
0.51

$
156,599


291,426

$
0.54Effect of
dilutive securities,
  net of tax:Options &
SARS





1,636








5,824Convertible
securities


3,675


8,000





3,534


8,000Diluted
earnings per share

$
152,130


300,000

$
0.51

$
160,133


305,250

$
0.52Note
8: The Company
maintains a shareholder approved incentive plan that allows for the issuance of
equity-based compensation awards, including stock options, stock appreciation
rights, share grants and restricted stock awards. The Company uses treasury
stock and newly issued stock to satisfy equity-based compensation awards. As of
September 30, 2006, there were approximately 32 million Company shares
available for issuance upon the exercise of outstanding employee stock options
and stock appreciation rights and for future grants. Also, as of September 30,
2006, there was approximately $20 million of total unrecognized compensation
expense related to non-vested share-based compensation arrangements. That cost
is expected to be recognized primarily over the next four years.

Note
9: The Companys
stock options and stock appreciation rights, collectively option(s), are
issued at a price not less than the fair market value on the grant date and
expire within 10 years of the grant date. Certain options may permit the holder
to pay the option exercise price by tendering Company shares that have been
owned by the holder without restriction for an extended period. Options
generally vest over a five year period.

In December 2004, the
Financial Accounting Standards Board issued SFAS No. 123 (revised 2004),
Share-Based Payment (SFAS 123(R)). SFAS 123(R) replaces SFAS 123, Accounting
for Stock-Based Compensation (SFAS 123), and supersedes Accounting Principles
Board Opinion 25, Accounting for Stock Issued to Employees (APB 25). SFAS
123(R) requires that stock options and share grants be recorded at fair value
and this value is recognized as compensation expense over the vesting period.
SFAS 123(R) requires that compensation expense be recorded for newly issued
awards as well as the unvested portion of previously issued awards that remain
outstanding as of the adoption of SFAS 123(R). The Company has adopted the
provisions of SFAS 123(R) effective January 1, 2006 using the modified
prospective method which requires application of the rule after January 1,
2006.

Prior to adopting SFAS
123(R), and beginning in 2003, the Company was using the Prospective Method
as permitted under SFAS 148, Accounting for Stock-Based Compensation  Transition
and Disclosure, an amendment of FASB Statement No. 123, which required the
Company to expense the fair value of new employee option grants awarded
subsequent to 2002. Related to the unvested option awards granted prior to
2003, the adoption of SFAS 123(R) in 2006 resulted in incremental compensation
expense for the nine months ended September 30, 2006 of approximately $2.4
million pretax, $1.4 million after-tax. For the full year 2006, the Company
expects the total incremental compensation expense related to adopting SFAS
123(R) to be approximately $3.0 million pretax, or $1.8 million after-tax.
Also, effective January 1, 2006, the Company reclassified within Shareholders
Equity the $14.4 million balance of Restricted stock (unearned compensation)
to Additional paid-in capital.

Prior to the adoption of
SFAS 123(R), the Company adjusted option expense related to forfeited options
as the forfeitures occurred. With the adoption of SFAS 123(R), the Company is
estimating the forfeitures that will occur and is recording periodic option
expense net of the estimated forfeitures. The cumulative impact of the change
in accounting for forfeitures was not material to the consolidated financial
statements.

The Company uses a
lattice-based option valuation model to value its option awards. Under a
lattice-based model, expected volatilities are based on a term structure of
implied volatilities from traded options on the Companys stock and historical
volatility of the Companys stock. The Company uses historical data to estimate option
exercises and employee terminations within the valuation model. The expected

10

term of options granted is derived from the output of the option valuation
model and represents the period of time that options granted are expected to be
outstanding. The range of risk-free rates for periods within the contractual
life of the options is based on the U.S. Treasury forward curve rate using a
term structure. Options granted to employees during the nine months ended
September 30, 2006 and 2005 had a weighted average fair value of $2.52 and
$2.80, respectively. The following assumptions were used for options awarded
during the nine months ended September 30, 2006 and 2005:

Nine
  Months Ended September 30,2006

2005Expected
  volatility


17.9% - 42.1
%

27.66% - 47.56
%Weighted-average
  volatility


19.00
%

28.24
%Expected
  dividends


3.00
%

3.41
%Expected
  term (in years)


9


6Risk-free
  rate


4.39% - 4.64
%

2.98% - 4.65
%Weighted-average
  risk-free rate


4.54
%

4.06
%The following table presents
the proforma impact on continuing operations for the three and nine months
ended September 30, 2005 of compensation expense relating to stock option
awards as computed under SFAS 123(R):

Three Months
  
  Ended

Nine Months
  
  EndedSept. 30,

Sept. 30,(In thousands, except per share data)

2005

2005Continuing
  Operations:Income as reported

$
70,172

$
156,599Add back: Stock-based
compensation expense included in reported net
  income, net of related tax effects


620


1,685Deduct: Stock-based
compensation expense determined under fair-value
  method, net of related tax effects


(1,380
)

(4,389
)Proforma net income

$
69,412

$
153,895Basic Earnings Per Share:As
reported

$
0.24

$
0.54Proforma

$
0.24

$
0.53Diluted Earnings Per Share:As
reported

$
0.23

$
0.52Proforma

$
0.23

$
0.52Total pretax option expense
and income tax benefits recognized was approximately $1.8 million and $.7
million, respectively for the three months ended September 30, 2006 and $5.0
million and $2.0 million, respectively, for the nine months ended September 30,
2006.

A summary of option activity
as of September 30, 2006 and changes during the nine months then ended is
presented below:

Shares

Weighted Avg. 
  Exercise Price

Remaining 
  Contractual 
  Term

Aggregate 
  Intrinsic value 
  (in thousands)Outstanding at December 31, 2005


29,508,273

$
12.96Granted to
employees


2,325,250

$
12.28Exercised


(1,970,959
)
$
9.64Terminated or
resigned


(1,689,802
)
$
14.56Total outstanding, September 30, 2006


28,172,762

$
13.04



3.4

$
10,135Total
  exercisable, September 30, 2006


22,045,583

$
13.32



2.3

$
8,45511

During the nine months ended September 30, 2006 and
2005, the total intrinsic value of awards exercised was approximately $6.1
million and $7.6 million, respectively. The aggregate intrinsic value of
outstanding and exercisable awards was $10.1 million and $8.5 million,
respectively at September 30, 2006 and $73.1 million and $41.2 million,
respectively at September 30, 2005. The cash received from the exercise of
options was approximately $18.5 million for the nine months ended September 30,
2006.

The following table summarizes the range of exercise
prices and the weighted average remaining contractual life of the options
outstanding and the range of exercise prices for the options exercisable at
September 30, 2006:

Range of
  Exercise Prices

Number
  Outstanding
  at 9/30/06

Weighted Average
  Remaining
  Contractual
  Term

Weighted
  Average
  Exercise Price

Number
  Exercisable
  at 9/30/06

Weighted
  Average
  Exercise Price$8.40      10.78


9,402,375


3 Years

$
10.13


7,581,693

$
10.10$10.80  15.94


13,121,084


4 Years

$
12.49


8,814,587

$
12.34$16.12  22.33


5,475,914


2 Years

$
18.18


5,475,914

$
18.18$27.20  77.56


173,389


1 Year

$
50.74


173,389

$
50.74$8.40    77.56


28,172,762


3.4 Years

$
13.04


22,045,583

$
13.32The options priced at $77.56 are options assumed by
the Company as a result of business acquisitions.

Note 10:
The Companys share grants and restricted stock awards have a general vesting
period of five years and are restricted as to the sale or transfer of the
shares prior to vesting. Restricted stock awards are non-transferable and
subject to forfeiture if the holder does not remain continuously employed by
the Company during the vesting period, or, if the restricted stock is subject
to performance measures, if those performance measures are not attained. The
fair value of the restricted stock awards is equal to the value of the Companys
stock on the date of grant. The Company includes the vested and unvested
portions of the restricted stock awards in shares outstanding in the
denominator of its earnings per share calculations.

Restricted stock awards granted to employees during
the nine months ended September 30, 2006 and 2005 have a weighted average fair
value of $12.11 and $13.39, respectively. A summary of the share grant and
restricted stock activity during the nine months ended September 30, 2006 is
summarized in the table below:

Shares

Weighted Average
  Grant-date
  Fair ValueOutstanding at
December 31, 2005


1,582,877

$
12.09Granted to
employees


624,757

$
12.11Vested/exercised


(479,826
)
$
11.80Terminated or
resigned


(620,093
)
$
12.37Total
outstanding, September 30, 2006


1,107,715

$
12.09Total pretax share grant and restricted stock
compensation expense for the nine months ended September 30, 2006 and 2005 was
approximately $3.2 million and $3.7 million, respectively, and the income tax
benefits recognized for these awards was approximately $1.3 million and $1.5
million, respectively.

Note 11:
In the Condensed Consolidated Statements of Cash Flows, the caption Cash and
Cash Equivalents includes investments in short-term, highly-liquid securities
having a maturity of three months or less. Supplemental information relating to
the Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2006 and 2005 is presented in the following table:

12

(in thousands)Cash paid for or (received from):

2006

2005Interest expense

$
54,673

$
54,784Interest and investment income


(19,486
)

(15,725
)Income taxes, net of refunds


26,644


141,496The increase in cash received from interest and
investment income primarily reflects a higher level of investment income and
gains realized on the growing investment portfolio at American Home Shield.
Cash paid for income taxes decreased in 2006 as a result of $131 million of
taxes paid last year to the Internal Revenue Service (IRS) and various states
pursuant to the Companys agreement with the IRS that was reached in January
2005.

Note 12: Total
comprehensive income was $65 million and $83 million for the three months ended
September 30, 2006 and 2005, respectively, and $130 million and $170 million
for the nine months ended September 30, 2006 and 2005, respectively. Total
comprehensive income primarily includes net income, changes in unrealized gains
and losses on marketable securities and foreign currency translation balances.

Note 13: The
Company has an agreement to provide for the ongoing revolving sale of a
designated pool of accounts receivable of TruGreen ChemLawn and Terminix to a
wholly owned, bankruptcy-remote subsidiary, ServiceMaster Funding LLC.
ServiceMaster Funding LLC has entered into an agreement to transfer, on a
revolving basis, an undivided percentage ownership interest in a pool of
accounts receivable to unrelated third party purchasers. ServiceMaster Funding
LLC retains an undivided percentage interest in the pool of accounts receivable
and bad debt losses for the entire pool are allocated first to this retained
interest. During the nine months ended September 30, 2006 and 2005, there were
no receivables sold to third parties under this agreement. However, the Company
may sell its receivables in the future, which would provide an alternative
funding source. The agreement is a 364-day facility that is renewable at the
option of the purchasers. The Company may sell up to $70 million of its
receivables to these purchasers and therefore has immediate access to cash
proceeds from these sales. The amount of the eligible receivables varies during
the year based on seasonality of the business and will, at times, limit the
amount available to the Company.

Note 14: In
the third quarter, the Company completed the sales of American Residential
Services (ARS) and American Mechanical Services (AMS), generating gross cash
proceeds of approximately $111 million that has been used to reduce outstanding
debt balances. Approximately $100 million of the total proceeds was received at
closing of the ARS sale on the last business day of the third quarter. This
amount is reflected as cash in the September 30, 2006 balance sheet and was
used to pay down debt on October 3, 2006. Total debt was $873 million at
September 30, 2006 (as previously discussed, the $100 million cash proceeds
from the ARS sale was used to pay down debt on October 3), approximately $215
million more than the amount at December 31, 2005. This increase reflects
funding for acquisitions, normal seasonal working capital needs and share
repurchases. Approximately 65 percent of the Companys debt matures
beyond five years and 56 percent beyond fifteen years. The
Companys next public debt maturity of $49 million is in August 2007. The
Company has both the intent and ability to pay this debt with other long-term
financing, and it is classified as long-term debt in the Consolidated
Statements of Financial Position.

Note 15:
The financial statement caption discontinued operations includes ARS and AMS.
The ARS/AMS operations provide heating, ventilation, air conditioning (HVAC),
plumbing and electrical installation and repair. In the first quarter of 2006,
the Company recorded a ($25) million after-tax provision for expected losses on
the disposition of certain ARS/AMS properties.
The Company completed sales of the ARS and AMS businesses, resulting in an after-tax
net loss of ($.7) million. As part of the ARS and AMS sale agreements, the
Company continues to be obligated to third parties with respect to bonds (primarily performance
and license type), operating leases for which the Company has been

13

released as
being the primary obligor, certain real estate leased and operated by the buyers, and
other guarantees of payment. The Companys obligations under these agreements
may be limited in terms of time and or amount, and in some cases, the Company
may have recourse against the buyers for certain payments made by the Company.
At the present time, the Company does not believe it is probable that the
buyers will default on their obligations subject to guarantee. The fair value
of the Companys obligations related to these guarantees is not significant.
Accordingly, no liability has been recorded related to these guarantees.

The Company has guarantees on certain bonds issued by
the divested companies, primarily performance and license type bonds. The
maximum payments the Company could be required to make if the buyers are unable
to fulfill their obligations is approximately $64 million at September 30,
2006. Approximately 60 percent of the bonds expire as of December 31, 2006,
with the remaining bonds expiring primarily through 2008. The Company believes
that if it were to incur a loss on any of these bond guarantees, the likelihood
of which the Company believes is remote, such loss would not have a material
effect on the Companys business, financial condition or results of operations.

The results of discontinued operations for the nine
months ended September 30 are as follows:

Nine months ended September 30,(In thousands, except per share data)

2006

2005Revenue

$
518,830

$
570,091Operating income

$
13,396

$
25,394Impairment charge


(42,000
)

Pretax income (loss)


(28,604
)

25,394Provision (benefit) for income
taxes


(11,693
)

10,033(Loss) on sale, net of
tax


(741
)

Income (loss) from discontinued
operations

$
(17,652
)
$
15,361Per diluted share income (loss)
from
  discontinued operations

$
(0.06
)
$
0.05The following table summarizes the activity during the
nine months ended September 30, 2006 for the remaining liabilities from other
previously discontinued operations and does not include the liabilities of the
sold ARS/AMS businesses. The liabilities of ARS and AMS include severance,
retention and wind-down costs that are expected to be paid by year-end.

(In thousands)

Balance at
  December 31,
  2005

Cash
  Payments
  or Other

Income/
  (Expense)

Balance at
  September 30,
  2006Remaining liabilities from 
  discontinued operations

$
16,036

$
5,854

$
(1,823
)
$
12,005Note
16: In the ordinary
course, the Company is subject to review by domestic and foreign taxing
authorities, including the IRS. As previously disclosed, the U.S. federal tax
returns filed by the Company through the 2005 return have been reviewed
by the IRS. The Company paid $5 million primarily in the first quarter of 2006
relating to the resolution of the 2003 and 2004 audits. In the first quarter of
2005, the IRS commenced the audit of the Companys tax return for 2005 and it was
completed in the fourth quarter of 2006 with no adjustments or additional payments.

14

Note 17:
In July 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48 Accounting for Uncertain Tax Positions (FIN 48). FIN 48
provides guidance on the accounting for and disclosure of tax positions
accounted for in accordance with Statement of Financial Accounting Standards
No. 109. FIN 48 requires that the effects of a tax position be initially
recognized when it is more likely than not (which is defined as a greater
than 50 percent chance) that the position will be sustained upon examination by
the taxing authorities. In addition, FIN 48 requires additional disclosures
regarding tax positions. FIN 48 is effective beginning January 1, 2007. The
Company is presently assessing the impact of FIN 48 to the Companys
consolidated financial position, results of operations and cash flows; however,
the Company does not expect the adoption of this Statement to have a material
effect on these Consolidated Financial Statements.

In September 2006, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 states
that registrants should use both the balance sheet approach and an income
statement approach when quantifying and evaluating the materiality of
misstatements. SAB 108 provides guidance on correcting errors under the dual
approach and provides transition guidance for correcting errors in prior years.
It is effective for the year ending December 31, 2006. The Company does not
expect the adoption of SAB 108 to have a material impact on the Companys
consolidated financial position, results of operations or cash flows.

Note 18:
The business of the Company is conducted through five operating
segments: TruGreen ChemLawn, TruGreen LandCare, Terminix, American Home
Shield and Other Operations and Headquarters. The TruGreen ChemLawn segment
provides residential and commercial lawn care services. The TruGreen LandCare
segment provides landscape maintenance services primarily to commercial
customers. The Terminix segment provides termite and pest control services to
residential and commercial customers. The American Home Shield segment provides
home warranties to consumers that cover heating, ventilation and air
conditioning, plumbing and other home systems and appliances. This segment also
includes home inspection services provided by AmeriSpec. The Other Operations
and Headquarters segment includes InStar Services Group, a direct provider of
commercial disaster response and reconstruction services as well as the
franchised and Company-owned operations of ServiceMaster Clean, Furniture Medic
and Merry Maids, which provide primarily residential disaster restoration,
commercial cleaning, carpet and upholstery cleaning, furniture repair and maid
services. The Other Operations and Headquarters segment also includes the
Companys headquarters operations, which provide various technology, marketing,
finance, legal and other support services to the business units. Segment
information is presented in the following table.

15

(In thousands)

Three Months
  Ended Sept. 30,2006

Three Months
  Ended Sept. 30,2005

Nine Months
  Ended Sept. 30,2006

Nine Months
  Ended Sept. 30,2005Operating
  Revenue:TruGreen
ChemLawn

$
342,375

$
341,200

$
837,069

$
822,019TruGreen
LandCare


116,383


117,443


334,236


337,389Terminix


269,213


266,986


830,487


820,347American Home
Shield


164,405


154,599


440,801


409,895Other
Operations and Headquarters


79,060


45,264


215,854


130,229Total
  Operating Revenue

$
971,436

$
925,492

$
2,658,447

$
2,519,879Operating Income (Loss)(1):TruGreen
ChemLawn

$
67,033

$
80,194

$
128,008

$
143,824TruGreen
LandCare


(1,138
)

(781
)

(5,545
)

(3,416
)Terminix


31,512


34,060


124,728


122,071American Home
Shield


20,506


22,851


54,104


60,802Other
Operations and Headquarters


(7,785
)

(12,478
)

(24,812
)

(36,094
)Total Operating Income

$
110,128

$
123,846

$
276,483

$
287,187(1)
Presented below is a
  reconciliation of segment operating income to income from continuing
  operations before income taxes.(In thousands)

Three MonthsEnded Sept. 30,
  2006

Three MonthsEnded Sept. 30,
  2005

Nine MonthsEnded Sept. 30,
  2006

Nine MonthsEnded Sept. 30,
  2005Segment
  Operating Income

$
110,128

$
123,846

$
276,483

$
287,187Non-operating
  expense (income):Interest
expense


16,081


13,749


46,604


43,729Interest
  and investment income, net


(7,136
)

(5,516
)

(18,685
)

(18,116
)Minority
  interest and other expense, net


2,066


2,080


6,189


6,173Income from
Continuing Operations before Income
  Taxes

$
99,117

$
113,533

$
242,375

$
255,401The combined operations of ServiceMaster Clean, InStar and Merry Maids,
which are included in the Other Operations and Headquarters segment, comprised
approximately eight percent and five percent of the consolidated revenue for
the three months and nine months ended September 30, 2006 and 2005,
respectively. These operations comprised approximately 11 percent and eight
percent of the consolidated operating income, before headquarter overheads, for
the three months ended September 30, 2006 and 2005, respectively, and 12
percent and 10 percent of the consolidated operating income, before headquarter
overheads, for the nine months ended September 30, 2006 and 2005, respectively.

16

(In thousands)

As of 
  September 30, 2006

As of 
  December 31, 2005Identifiable Assets:TruGreen
ChemLawn

$
969,717

$
885,153TruGreen
LandCare


97,565


92,694Terminix


902,456


862,270American Home
Shield


585,813


530,486Other Operations & Headquarters


696,770


658,267Total Identifiable Assets

$
3,252,321

$
3,028,870(In thousands)

As of 
  September 30, 2006

As of 
  September 30, 2005Capital Employed: (2)TruGreen
ChemLawn

$
916,112

$
882,241TruGreen
LandCare


43,389


37,629Terminix


679,003


634,164American Home
Shield


244,977


202,152American
  Home Shield without Cash and marketable securities (2)


(60,569
)

(76,660
)Other Operations & Headquarters


132,389


164,266Total Capital Employed

$
2,015,870

$
1,920,452(2)
Capital employed is a non-GAAP measure that is
  defined as the segments total assets less liabilities, exclusive of debt
  balances. The Company believes this information is useful to investors in
  helping them compute return on capital measures and therefore better
  understand the performance of the Companys business segments. The
  calculation of capital employed for the American Home Shield segment includes
  approximately $306 million and $279 million of cash and marketable securities
  at September 30, 2006 and 2005, respectively. The investment income and
  realized gains/losses on these assets are reported below operating income in
  non-operating income/expense. In order to facilitate the comparison of return
  on invested capital for the American Home Shield segment, the Company has
  also presented capital employed for this segment excluding cash and
  marketable securities. The negative capital employed balances primarily
  result from deferred revenue and amounts payable to subcontractors. Presented
  below is a reconciliation of total segment capital employed to the most
  comparable GAAP measure.(In thousands)

As of 
  September 30, 2006

As of 
  September 30, 2005Total Assets

$
3,252,321

$
3,145,997Less:Current liabilities, excluding current portion of
  long-term debt


897,805


928,352Long-term liabilities


338,646


297,193Total Capital Employed

$
2,015,870

$
1,920,452Note 19:
In the ordinary course of conducting its business activities, the Company
becomes involved in judicial, administrative and regulatory proceedings
involving both private parties and governmental authorities. These proceedings
include general and commercial liability actions and a small number of environmental proceedings. The Company does not expect
any of these proceedings to have a material adverse effect on its Consolidated
Financial Statements.

17

On September 29, 2006, the United States Attorneys
Office for the Southern District of Florida (U.S. Attorneys Office) filed an
Information against InStar Services Group, Inc. that charged InStar with two
felony counts of violating the Clean Air Act. InStar and the U.S. Attorneys
Office entered into a plea agreement that was approved by the Court on November
8, 2006. Under the plea agreement, InStar pled guilty to the two felony counts
and the U.S. Attorneys Office agreed not to file any additional criminal
charges in the Southern District of Florida against InStar. The plea agreement
requires InStar to implement an environmental compliance plan, be placed on
probation for a period of up to five years, pay a fine of $500,000 for each
count, and make a contribution of $2,000,000 to the Florida Environmental Task
Force Trust Fund. Under the plea agreement, the Company has agreed to take all
reasonable steps necessary to ensure the implementation and enforcement of the
environmental compliance plan by InStar.

Since the conduct of InStar that is the subject of the
plea agreement occurred prior to the Companys acquisition of InStar, the
Company is seeking indemnification from the sellers of InStar for the amount of
its damages and expenses including fines, contributions and attorneys fees up
to $5.5 million. The Company believes that it is clearly entitled to complete
indemnification under the terms of the acquisition agreement.

The Company believes that any disruption to the InStar
business arising from the plea will not have a material effect on the Companys
financial condition or results of operations.

18

MANAGEMENT
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

BUSINESS OVERVIEW AND OUTLOOK FOR 2006

ServiceMaster (the Company) was adversely impacted
during the months of August and September by the combination of intense summer
weather across the country, execution issues and rising factor costs. TruGreen ChemLawn
experienced an increase in service calls while sales fell short of
expectations. American Home Shield experienced higher than expected claim
volume and a higher average cost per claim. While at Terminix, the
industry-wide decline in termite lead flow that began earlier in the year, continued
in the third quarter. This was mitigated somewhat by continued solid
improvements in the Companys lead to sales conversion rate. There were also
positive developments in the quarter that the Company believes will help it
return to stronger performance. Customer retention, a top priority throughout
the enterprise, improved in every business unit. At American Home Shield, the
Company launched its new business partnership with Realogy, the worlds largest
real estate brokerage firm, which includes the Coldwell Banker, Century 21 and
ERA brands. Project Accelerate, the Companys initiative to enhance the
efficiency and effectiveness of its support functions, is proceeding ahead of
schedule. In addition, the Company believes it has improved its performance
profile by successfully divesting American Residential Services and American
Mechanical Services during the third quarter.

Outlook

The Company expects that earnings per share from
continuing operations excluding the impact of net restructuring charges associated
with Project Accelerate and the Companys recently announced decision to
consolidate its headquarters in Memphis, will be in the range of $.61 to $.63,
consistent with or slightly improved over the $.61 of comparable earnings per
share reported in 2005.

THIRD QUARTER 2006 COMPARED TO 2005

The Company reported third quarter 2006 revenue of
$971 million, a five percent increase compared to 2005. Approximately four
percent of the increase in revenue resulted from acquisitions, primarily InStar
Services Group (InStar), which was acquired at the end of February 2006. Total
diluted earnings per share (i.e., from both continuing operations and
discontinued operations) were $.23 compared to $.27 in 2005. Diluted earnings
per share from continuing operations were $.21, compared with $.23 in 2005.
Operating income for the third quarter was $110 million compared to $124
million in the prior year.

The decline in operating income was attributable to
the combination of flat revenue growth in three of the Companys large business
units, rapid increases in fuel, health care and interest costs throughout the
Company, higher costs per claim at American Home Shield, and investments to
improve customer satisfaction and retention. These were partially offset by
increased operating profits from the franchised businesses, the first time
inclusion of operating profits from InStar, and continued reductions in
functional support costs.

Much higher fuel, health
care, and interest costs continued to provide stiff headwinds during the third
quarter, with a combined adverse impact relative to the prior year of almost
$12 million. With respect to fuel, the Companys fleet, which consumes roughly
30 million gallons annually, continues to be negatively impacted by significant
increases in oil prices. Each year, the Company hedges approximately two-thirds
of its estimated annual fuel usage, but this years hedge prices are well above
last years. Higher fuel and fertilizer costs (which are also impacted by
energy prices) adversely impacted third quarter results by almost $3.5 million,
and the nine month results by over $13 million. For the full year, if pump
prices stay at current levels, the Company expects increased fuel expense over
last year of over $.03 per share. Based upon the hedges the Company has
executed to date for 2007, as well as current

19

Department of Energy price
forecasts, the Company would again expect an incremental adverse impact next
year, but at a lower rate of increase of approximately $.01 to $.02 per share.

Health care costs continue
to experience strong inflationary pressures. As previously disclosed, the
Company has made an incremental investment in employee health benefits in 2006
as part of its efforts to further enhance employee satisfaction and retention.
No similar benefit enhancement will be required in 2007. In total, health care
and related costs increased approximately $4 million in the third quarter and
$9 million in the first nine months, with an incremental impact of
approximately $13 million expected for the year as a whole.

Increases in short term
interest rates have adversely impacted the Companys businesses at the
operating income level by virtue of their effects on floating rate-based fleet
and occupancy leases. The Company estimates that the increases in interest
rates resulted in incremental lease expense of approximately $1.5 million in
the third quarter and $4.5 million year-to-date.

On the positive side, the
Company continues to make strides in reducing the costs that it can more directly
control. The Company has maintained its focus and momentum in driving down
safety-related costs, the impact of which is most prominently manifested in
continuing favorable trends of prior year claims. In total, safety-related
costs declined approximately $12 million for the first nine months.
Safety-related costs were relatively flat in the third quarter and are expected
to continue to be flat in the fourth quarter, consistent with the very strong
results achieved in the comparable periods of 2005.

The Company is tracking
ahead of schedule with respect to realizing its previously
forecasted savings from Project Accelerate, an internal, multi-phase
restructuring project designed to realign the Companys cost structure in light
of divestitures and create a more effective and efficient functional support
structure. The Company remains confident that it will ultimately realize annual
pretax savings, net of reinvestments, in the $25 million to $35 million range,
or $.05 to $.07 per share, by 2008. The Company expects to realize these
savings progressively with $.03 to $.04 per share of net savings expected to be
realized in 2006. Most of these savings will benefit the selling, general and
administrative line in the statement of operations, although some savings, such
as those from safety and sourcing initiatives, will benefit cost of sales.
Severance and other restructuring costs resulting from the organizational
changes of Project Accelerate and the resignation in the second quarter of the Companys
former Chief Executive Officer totaled $.9 million in the third quarter of 2006
and $10.7 million for the first nine months of 2006. These charges are reported
in the Restructuring charges line in the Consolidated Statements of
Operations and are recorded in the Other Operations and Headquarters business
segment. The Company expects that the charges related to the aforementioned
organizational changes will be incurred and recognized prior to the end of the
year, and should approximate $11 to $12 million in total.

On October 30, 2006, The ServiceMaster Company
announced a plan to consolidate its corporate headquarters into its operations
center in Memphis, Tennessee and close its current headquarters in Downers
Grove, Illinois. The transition to Memphis is targeted to be completed by July
2007. The Board of Directors of the Company approved the action on October 27,
2006.

The Companys operating business units and leadership
are already headquartered in Memphis and currently employ over 2,300 individuals.
A number of company-wide support functions are also already located there, and
are included in that employment total. The Downers Grove, Illinois office
currently employs approximately 170 individuals, virtually all of which will be
impacted by the decision to consolidate headquarters. The Downers Grove
functions affected by the consolidation include corporate accounting, treasury
and finance, tax, and portions of the legal, information technology, marketing,
and mergers and acquisitions functions. The Company believes the consolidation
of Downers Grove support functions and positions with operating unit leadership
in Memphis will improve the speed and effectiveness of communications and
decision-making. The relocation to Memphis is targeted to be completed by July
2007.

20

In connection with the consolidation plan, the Company
expects to incur incremental costs in the range of $25 to $30 million over the
next nine months. Such costs include employee retention and severance costs of
approximately $16 to $19 million, lease termination costs of approximately $5
million, and employee relocation, recruiting and training costs of
approximately $4 to $6 million. Almost all such costs will be cash
expenditures. In accordance with U.S. generally accepted accounting principles,
the Company expects to recognize approximately $10 million of these charges in
the fourth quarter of 2006, with the remaining charges being recognized in
fiscal 2007.

In addition to the charges noted above, the Company
expects to incur certain other cash charges throughout the consolidation
process. These additional charges include training of replacement employees,
the costs related to headcount overlap during a transitional training period,
and temporary employee staffing, should the need arise. While the estimate of
these costs is not yet final, the Company currently expects that it will
total approximately $3 million (pre-tax), with virtually all occurring during the first half of
2007 related to these factors.

In connection with the consolidation, the Company
expects to realize reductions in travel and rent costs of approximately $3 to
$4 million per year, with full realization of these annual savings beginning in
2008. Additionally, savings are expected to be realized from State and Local tax
incentives, the net present value of which is comparable to the costs of the
consolidation. These incentives are expected to be realized over a period of 8
to 20 years, depending on their type.

Cost of services rendered and products sold increased
six percent in the third quarter. As a percentage of revenue, these costs
increased to 61.7 percent in 2006 from 60.8 percent in 2005, due in part to
increased contract costs per claim at American Home Shield and increased health
benefit and fuel costs throughout the enterprise. Selling and administrative
expenses increased nine percent in the third quarter. As a percentage of
revenue, these costs increased to 26.6 percent in 2006 from 25.6 percent in
2005, primarily reflecting differences in the timing of sales and marketing
costs and increases associated with expanded direct mail efforts at TruGreen
ChemLawn. These items were offset in part by reductions in functional support
costs.

Net non-operating expenses increased approximately
$0.7 million in the third quarter, primarily reflecting increased interest
expense due to higher interest rates, as well as higher debt balances, offset
in part by higher investment income. The higher investment income includes an
increase in the market value of investments within the employee deferred
compensation trust for which there is a corresponding offsetting increase in
compensation expense within operating income.

Segment Reviews for the Third Quarter 2006 Compared
to 2005

The
following business segment reviews should be read in conjunction with the
required footnote disclosures presented in the Notes to the Condensed
Consolidated Financial Statements. This disclosure provides a reconciliation of
segment operating income to income from continuing operations before income
taxes, with net non-operating expenses as the only reconciling item. The
Companys business segment reviews include discussions of capital employed,
which is a non-GAAP measure
that is defined as the segments total
assets less liabilities, exclusive of debt balances. The Company believes this
information is useful to investors in helping them compute return on capital
measures and therefore better understand the performance of the Companys
business segments. The Notes to the
Condensed Consolidated Financial Statements also include a reconciliation of
segment capital employed to its most comparable GAAP measure.

21

The TruGreen ChemLawn segment, which provides lawn
care services to residential and commercial customers, reported revenues of
$342 million, comparable to the prior year. The segment reported operating
income of $67 million compared to $80 million in 2005. The revenue comparison
for the third quarter was impacted by an increase this year in the number of
customer service calls resulting from increased crabgrass treatments as well as
lawn quality assessments, which together caused certain scheduled revenue producing services to
be delayed into the fourth quarter. Customer counts are down compared to the prior year,
however, retention improved throughout the quarter. The Company continues to expand its efforts
to improve customer satisfaction and retention. These efforts have included the
initiation of a program of lawn quality assessments (LQAs), which are customer
visits to evaluate the condition of the lawn and landscape; implementing faster
response standards and follow-up calls on re-services; and improved customer
communication and problem resolution procedures. The Company is encouraged by the
initial positive results of its LQA program, as the initial retention rate for samples of new
customers that received an LQA was significantly higher than samples of new
customers that did not receive an LQA. The third quarter decline in operating
income resulted from increased costs associated with expanded direct mail
efforts and timing differences in the recognition of sales and marketing
expenses, first time investments associated with the implementation of the LQA program and increased service calls,
as well as higher health insurance and fuel costs. Capital employed
in the TruGreen ChemLawn segment increased four percent, primarily reflecting
the impact of tuck-in acquisitions.

The TruGreen LandCare segment, which provides
landscape maintenance services primarily to commercial customers, reported a
one percent decrease in third quarter revenue to $116 million compared to $117
million in 2005, and an operating loss of ($1.1) million compared to ($0.8)
million in 2005. Base contract maintenance revenue was comparable to the prior
year, while revenue from enhancement sales (e.g., add-on services such as
seasonal flower plantings, mulching, etc.) decreased two percent in the third
quarter. TruGreen LandCare has substantially increased the size, caliber and
training of its sales team. In addition, management is using new tools to
identify and pursue larger and more profitable accounts. This has resulted in
improvements in the relative size and quality of outstanding sales proposals,
which should lead to improving growth in base contract maintenance revenues in
the future. In total, TruGreen LandCares fourth quarter revenues are expected
to be comparable to the prior year, as gains in base contract maintenance are
offset by reduced enhancement revenue due to non-recurring hurricane-related
work that was completed last year. The third quarter operating loss increased
as a result of higher fuel, health insurance and sales costs. Capital employed
in the TruGreen LandCare segment increased 15 percent, primarily due to
increased accounts receivable levels.

The Terminix segment, which includes termite and pest
control services, reported a one percent increase in third quarter revenue to
$269 million, compared to $267 million in 2005. Operating income decreased
seven percent to $32 million compared to $34 million in 2005. Terminixs
overall revenue growth for the third quarter reflected solid and improving
growth on the pest control side of the business, offset in part by a decline in
termite completion revenue. Revenue from pest control services, which represent
approximately one-half of the annual revenues of the Terminix segment,
increased six percent in the third quarter, supported by solid growth in
residential and commercial unit sales, an improvement in retention, and the
impact of acquisitions. At the beginning of the fourth quarter, Terminix
acquired Safeguard Pest Control. This acquisition, with annual revenues of over
$23 million, should have an additional positive impact on pest control growth
in the fourth quarter and into the future. Revenue from initial termite
applications (termite completions) declined nine percent in the third quarter
as a result of a combination of factors. Sales leads for renewable contracts
were down 15 percent in the quarter; however, the lead to sales conversion rate
improved. This resulted in a four percent increase in renewable unit sales,
which should benefit renewal revenues in future periods. The increase in
renewable unit sales was, in turn, offset by the combined effects of a
continued shift in mix from the bait product to lower priced liquid treatments,
as well as less revenue being recognized in the current year from prior year
sales. This latter factor resulted from the change to a new bait product in early 2005 which, because of
different operational requirements, resulted in less revenue to be
deferred into future periods. This factor should not have a recurring impact in
2007 and beyond. Revenue from termite contract renewals was comparable to the
prior year as improved pricing and a modest improvement in retention was offset
by a shift in mix of the renewal base to more liquid customers, which are at a
lower price than bait. Third quarter operating income

22

declined as a result of increases in fuel and health
costs, combined with differences in the timing of sales and marketing costs,
offset in part by continued favorable trends in termite damage claim costs and
lower termite material costs. Capital employed in the Terminix segment
increased seven percent, reflecting the impact of tuck-in acquisitions.

The American Home Shield segment, which provides home
warranties to consumers that cover heating, ventilation and air conditioning
(HVAC), plumbing and other home systems and appliances, reported a six percent
increase in revenue to $164 million from $155 million in 2005 and operating
income of $21 million in 2006 compared to $23 million in 2005. New contract
sales and renewals, which are reported as earned revenue over the subsequent
twelve-month contract period, increased six percent in the third quarter.
Revenue from customer renewals, which represent approximately 55 percent of
total annual contracts written, increased double-digits, supported by a larger
base of renewable customers and continued strong improvements in retention.
This growth was partially offset by declines in new sales in both the real
estate and direct to consumer channels. Unit sales from the real estate
channel, which represents approximately 30 percent of total annual contracts
written, were down 15 percent in the third quarter, due to a pervasive
weakening in the home resale market. This was particularly acute in several of
American Home Shields largest volume states, especially California. The
Company believes it has maintained or slightly increased market share in most
areas. The recently signed agreement with Realogy, which includes the Coldwell
Banker, Century 21 and ERA brands, is strategically very important and should
help generate overall growth in real estate sales in the fourth quarter despite
a weak market. In the first full year of the contract, the Company expects
incremental sales to exceed 100,000 units, or approximately $40 million, while
initial costs of the agreement will result in a minimal impact to operating
income in the first year, but an increasingly positive profit impact in subsequent years.
The annual level of incremental sales is expected to
double over the five year contract term, as the Company expands penetration of
the franchised outlets of these brands and increases contract renewals. The
direct to consumer channel, which represents approximately 15 percent of total
annual contracts written, experienced a four percent decline in third quarter
unit sales due to lower response rates on certain direct mail programs. The decline
in operating income primarily resulted from increases in average costs per
claim. Higher air conditioning related costs were influenced by a higher mix of
replacements versus repairs, which in turn were at relatively higher costs than
last year due to the required conversion to more efficient 13 SEER units as a
result of legislation that become effective earlier this year. Claim costs in
other areas, such as appliance and plumbing, were also higher as a result of
inflationary pressures. Capital employed in the American Home Shield segment
increased 21 percent, primarily reflecting a higher level of cash and
marketable securities due to the growth in the business and improved investment
performance. Capital employed at American Home Shield, which totaled $245
million and $202 million at September 30, 2006 and September 30, 2005,
respectively, includes $306 million and $279 million of cash, short-term and
long-term marketable securities at those dates. The investment income and
realized gains/losses on these assets are reported as non-operating
income/expense.

The Other Operations and Headquarters segment includes
the operations of ServiceMaster Clean, InStar and Merry Maids as well as the
Companys headquarters functions. Revenue in this segment increased to $79
million from $45 million in 2005. Revenues from InStar (which was acquired on
February 28, 2006) were $29 million in the third quarter, with operating
income, net of first-year acquisition-related amortization costs, of $1.7
million. InStars third quarter results were below managements expectations
due to a reduced level of hurricane activity, which was well below last year.
The ServiceMaster Clean and Merry Maids franchise operations reported a
combined increase in third quarter revenue of 11 percent, driven by continued
strong growth in disaster restoration and solid internal growth in residential
maid service.

The Other Operations and Headquarters segment
operating loss for the quarter was ($8) million compared with ($12) million in
2005. Included in the third quarter 2006 operating loss are restructuring
charges of $0.9 million. The improvement in the segment operating loss
primarily resulted from lower overhead and incentive compensation costs, the
first-time inclusion of operating profits from InStar, and an increase in
profits in the combined franchise operations. Capital employed in this segment
decreased, primarily

23

reflecting the realization of the annual tax benefit
associated with the amortization of tax intangible assets that will continue
through 2012.

NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO 2005

The Company reported revenue of $2.7 billion for the
nine months ended September 30, 2006, a five percent increase compared to 2005.
Approximately two percent of the increase in revenue was from organic sources.
Total diluted earnings per share (continuing operations and discontinued
operations) were $.45 compared to $.57 in 2005.

Diluted earnings per share from continuing operations
were $.51, compared to $.52 in 2005. Operating income for the nine months was
$276 million compared to $287 million in the prior year. As more fully
described in the third quarter comparison, the nine month results for 2006
include $10.7 million (or $.02 per share) of restructuring charges related to organizational
changes implemented at the Company. Operating income results included continued
favorable trending of prior year insurance claims, lower functional support
costs, the first-time inclusion of operating profits from the InStar
acquisition and improved profits at Terminix. These factors were partially
offset by the restructuring charges and lower profits in several business
segments, which are more fully discussed in the segment reviews.

Cost of services rendered and products sold increased
six percent and increased as a percentage of revenue to 61.9 percent in 2006
from 61.4 percent in 2005, primarily reflecting the impact of fuel and other
factor cost increases throughout the enterprise. Selling and administrative
expenses increased five percent for the nine months. As a percentage of
revenue, these costs decreased to 27.0 percent in 2006 from 27.1 percent in
2005, primarily reflecting improved sales labor efficiency at Terminix and
lower support costs.

Net non-operating expenses increased approximately
$2.3 million for the nine months, primarily reflecting an increase in interest
expense resulting from higher debt balances, due in part to the InStar
acquisition, as well as higher interest rates.

Key
Performance Indicators

The table below presents selected metrics related to
customer counts and customer retention for the three largest profit businesses
in the Company. These measures are presented on a rolling, twelve-month basis
in order to avoid seasonal anomalies.

Key Performance Indicators 
  As of September 30,2006

2005TruGreen ChemLawn-Growth in Full Program Contracts


-2
%

1
%Customer Retention Rate


64.6
%

64.1
%Terminix -Growth in Pest Control Customers


4
%

4
%Pest Control Customer Retention Rate


78.9
%

77.7
%Growth in Termite Customers


0
%

0
%Termite Customer Retention Rate


87.4
%

87.3
%American Home Shield -Growth in Warranty Contracts


0
%

6
%Customer Retention Rate


58.1
%

56.5
%24

Segment Reviews for the Nine Months Ended
September 30, 2006 Compared to 2005

As discussed
in the third quarter comparison, the following business segment reviews should
be read in conjunction with the required footnote disclosures presented in the
Notes to the Condensed Consolidated Financial Statements.

For the nine
months, the TruGreen ChemLawn segment reported a two percent increase in
revenue to $837 million compared to $822 million in 2005 and operating income
of $128 million compared to $144 million in 2005. The increase in revenue
reflects improved price realization, combined with increases in supplemental
services and commercial revenues. Year-to-date, the Company has realized a two
to three percent increase in average prices. Partially offsetting these sources
of growth was a two percent reduction in customer counts. The primary challenge
impacting customer counts has been significant declines in telemarketing sales
due to the expansion of Do Not Call lists and caller ID mechanisms. These
declines have more than offset double-digit growth in sales from newer
channels, including direct mail and neighborhood programs. In 2007 and beyond,
the Company will continue to reduce its reliance on telemarketing. Direct mail
programs will become more dominant, supplemented by improved and expanded
neighborhood, internet and other sales efforts. Customer retention for the
rolling, twelve months ended September 30 increased 50 basis points, a sharp
improvement from the declines that existed in the first half of the year. The
Company is expecting continued improvements in retention with gains of over 100
basis points projected by the end of the year. The decrease in operating income
for the nine months was attributable to increased health insurance, fuel,
fertilizer, marketing and variable vehicle lease costs.

The TruGreen
LandCare segment reported a one percent decrease in revenue for the nine months
to $334 million compared to $337 million in 2005, and an operating loss of
($5.5) million compared to ($3.4) million in 2005. The decline in revenue for
the nine months resulted from a $7 million decrease in first quarter snow
removal service revenue, offset in part by three percent growth in enhancement
revenue. Base contract maintenance revenue was comparable to the prior year for
the nine months. Recent investments in the sales function are expected to lead
to increasing contract maintenance revenues beginning in the fourth quarter.
The increase in the nine month operating loss resulted from a reduction in
first quarter operating profits of $4 million due to a lower level of high
margin snow removal revenue and increased fuel costs, offset in part by
favorable trending in safety costs.

Revenue for
the nine months in the Terminix segment increased one percent to $830 million
compared to $820 million in 2005. Operating income increased two percent to
$125 million compared to $122 million in 2005. As discussed in the third
quarter comparison, this segments overall revenue growth for the nine months
reflected solid and improving growth on the pest control side of the business,
offset in part by a decline in termite completion revenue. Pest control revenue
increased five percent, supported by increased momentum in residential sales,
good commercial growth, an improvement in retention of 120 basis points, as
well as the impact of acquisitions. Lower initial termite completion revenues
resulted from the industry-wide decline in termite lead flow that began during
the weak termite swarm season in the first half of the year and continued into
the third quarter, as well as the effects of a continued shift in mix from bait
to lower priced liquid treatments. Unit sales of termite completions increased
three percent for the nine months, despite the decline in lead flow due to
substantial improvements in lead to sale conversion rates. Revenue from termite
contract renewals increased modestly for the nine months, supported by improved
pricing and a 10 basis point improvement in retention. The growth in operating
income primarily reflects the favorable impact on comparisons of a correction recorded last year in
estimating prior years termite damage claim reserves, as well as continued
favorable trends in current termite damage claims expense resulting from product and
process improvements. Operating income growth also reflects lower termite material costs, and improved sales labor
productivity, offset in part by higher fuel prices and health insurance costs.

The American
Home Shield segment reported an eight percent increase in revenue for the nine
months to $441 million from $410 million in 2005 and a decrease in operating
income to $54 million from $61 million in 2005. Warranty contract sales and
renewals, which are reported as earned revenue over the

25

subsequent
twelve-month contract period, increased five percent for the nine months. For
the nine months, revenue from customer renewals increased double-digits,
supported by improved retention. Retention rates improved 160 basis points,
reflecting a more favorable mix of renewing customers, the effects of customer
satisfaction follow up calls after service visits, and a significant
improvement in problem resolution ratings from customers. Unit sales from the
real estate channel declined ten percent in the first nine months as home
listings and closings were impacted by a weakening home resale market, which was
particularly acute in California and several other states where the Company has
a major presence. As noted in the three month comparison, American Home Shield
signed a significant agreement with Realogy, the worlds largest real estate
brokerage firm. This agreement is expected to have an increasingly favorable
impact on sales beginning in the fourth quarter. Unit sales in the direct to
consumer channel declined six percent for the nine months, primarily due to
lower response rates on certain direct mail programs. The decrease in operating
income reflects higher contract claim costs from
inflationary pressures and new HVAC legislation as well as incremental investments in
initiatives to expand the real estate sales force, increase market penetration and improve
customer retention.

The Other
Operations and Headquarters segment reported revenue of $216 million for the
nine months, compared to $130 million in 2005. The 2006 figure includes $73
million of revenue from InStar (acquired on February 28, 2006) for the seven
month period since closing, with operating income, net of first-year
acquisition-related amortization costs, of $5.1 million. InStars revenue for
the seven month period since closing were below managements expectations due
to a reduced level of hurricane activity, but reflected solid progress in
InStars efforts to diversify into non-catastrophic sales channels, such as
rehabbing buildings to comply with the American Disabilities Act. While profits
were also below expectations, due to the hurricane factor and costs associated
with improvements in InStars asbestos removal procedures, the acquisition is
still expected to be modestly accretive for 2006. The project backlog is
comparable to prior year levels, as reductions in hurricane work have been
offset by increases from other channels. On a combined basis, the ServiceMaster
Clean and Merry Maids franchise operations achieved an 11 percent increase in
revenue for the nine months. The Other Operations and Headquarters segment
operating loss for the nine months was ($25) million compared to a loss of
($36) million in 2005. Included in the nine month 2006 operating loss are
restructuring charges associated with Project Accelerate of $10.7 million. The segment operating loss improved by
$11 million, despite the inclusion of the restructuring charges, primarily reflecting favorable trending of prior year insurance
claims, lower overhead and incentive compensation expense, the first-time
inclusion of profits from the InStar acquisition and increased profits from the
combined franchise operations, offset in part by the aforementioned
restructuring charges.

FINANCIAL POSITION AND LIQUIDITY

Cash Flows from
Operating Activities from Continuing OperationsNet cash provided from operating activities from continuing operations
for the nine months was $156 million, compared to $106 million in the prior
year. The increase in cash provided from operating activities from continuing
operations primarily reflects the $131 million tax payment made in 2005
relating to the 2005 IRS agreement which concludes audits covering the periods through 2002. In February 2006, the IRS concluded the
2003 and 2004 audits of the Companys tax returns and during the nine months
ended September 30, 2006, the Company made a resulting payment of $5 million to the IRS
and various states. Excluding tax payments from the resolution of IRS audits in
both periods, nine month cash provided from operating activities from
continuing operations decreased by $76 million. This decline resulted primarily
from higher working capital requirements associated with the InStar business,
lower levels of customer pre-payments at American Home Shield due to the
decline in sales from its real estate channel, severance and other cash
payments associated with Project Accelerate and the timing of insurance, tax
and other vendor payments.

The
year over year comparison of cash provided from operating activities from
continuing operations is expected to improve in the fourth quarter as a result
of normal seasonal patterns and intensified management focus. Excluding the impact of the IRS agreements,
the Company expects full year cash provided from operating activities to again
substantially exceed net income, but fall short of last years totals. This

26

expected result
reflects a solid earnings base, businesses that need relatively little working
capital to fund growth in their operations, and significant annual recoveries
of tax assets.

The significant annual cash
tax benefit results from a large base of intangible assets which are
amortizable for income tax reporting purposes, but not for book purposes. A
significant portion of these assets arose in connection with the Companys 1997
conversion from a master limited partnership to a corporation. The amortization of the
tax basis will result in approximately $50 to $55 million of average annual cash tax
benefits through 2012 for which no corresponding income statement benefit is
recorded.

In the ordinary course, the
Company is subject to review by domestic and foreign taxing authorities,
including the IRS. In the first
quarter of 2005, the IRS commenced the audit of the Companys 2005 tax return
and it was completed in the fourth quarter of 2006, with no adjustments.

Cash Flows from
Investing Activities from Continuing OperationsCapital expenditures increased over the prior year and included
recurring capital needs and information technology projects. The Company
anticipates approximately $50 million of capital expenditures in total in 2006,
reflecting investments in information systems and productivity enhancing
operating systems. The Company has no material capital commitments at this
time.

Acquisitions
for the nine months ended September 30, 2006 totaled $151 million, compared
with $44 million in 2005. This increase includes the acquisition of InStar, a
leading direct provider of commercial disaster response and reconstruction
services, for approximately $85 million of cash, as well as tuck-in
acquisitions, primarily in the Terminix and TruGreen ChemLawn businesses.
Consideration paid for tuck-in acquisitions consisted of cash payments, seller
financed notes and Company stock. The Company expects to continue its tuck-in
acquisition program at both Terminix and TruGreen ChemLawn.

Cash Flows from
Financing Activities from Continuing OperationsCash dividends paid to shareholders totaled $99 million or $.34 per
share for the nine months ended September 30, 2006. In October 2006, the
Company announced the declaration of a cash dividend of $.12 per share, payable
on November 30, 2006 to shareholders of record on November 13, 2006. This
represents a nine percent increase from the $.11 per share paid in last years
fourth quarter. The annual dividend rate of $.46 per share represents a 4.5
percent increase over 2005 levels, and makes 2006 the companys 36th
consecutive year of increases, putting ServiceMaster in the top two percent of
all public companies in America in terms of consistency of dividend growth. The
timing and amount of future dividend increases are at the discretion of the
Board of Directors and will depend, among other things, on the Companys
capital structure objectives and cash requirements at that time.

In February
2006, the Board of Directors authorized $250 million for share repurchases.
This authorization replaced the unused portion ($30 million at December 31,
2005) from the previous authorization approved in July 2000. The Company
completed approximately $86 million in share repurchases in the nine months
ended September 30, 2006, at an average price of $11.78 per share. There
remains approximately $179 million available for repurchases under the February
2006 authorization. Based on the current trending of repurchases and the
Companys commitment to maintain an investment grade credit rating, share
repurchases for the full year are expected to be in the $100 million to $120
million range, more than double the $52 million repurchased in 2005. The actual
level of future share repurchases will depend on various factors, including the
Companys commitment to maintain an investment grade credit rating and other
strategic investment opportunities.

LiquidityIn the third quarter, the Company completed the sales of
ARS and AMS, generating gross cash proceeds of approximately $111 million that
has been used to reduce outstanding debt balances. Approximately $100 million
of the total proceeds was received at closing of the ARS sale on the last
business day of the

27

third quarter.
This amount is reflected as cash in the September 30, 2006 balance sheet and was
used to pay down debt on October 3, 2006. Cash and short and long-term
marketable securities totaled approximately $494 million at September 30, 2006
(and included the $100 million of cash proceeds from the ARS sale), compared
with $367 million at December 31, 2005. Approximately $393 million of the 2006
amount is effectively required to support regulatory requirements at American
Home Shield and for other purposes. Total debt was $873 million at September
30, 2006 (as previously discussed, the $100 million cash proceeds from the ARS
sale was used to pay down debt on October 3), approximately $215 million more
than the amount at December 31, 2005. This increase reflects funding for
acquisitions, normal seasonal working capital needs and share repurchases.

Approximately
65 percent of the Companys debt matures beyond five years and 56 percent
beyond fifteen years. The Companys next public debt maturity of approximately
$49 million is in August 2007. The Company has both the intent and ability to
pay this debt with other long-term financing.

Management
believes that funds generated from operating activities and other existing
resources will continue to be adequate to satisfy ongoing working capital needs
of the Company. The Company maintains a revolving credit facility of $500
million. As of September 30, 2006, the Company had $180 million of borrowings
outstanding under this facility and had issued approximately $130 million of
letters of credit, resulting in unused revolving credit commitments of approximately $190 million.
The Company also has $550 million of senior unsecured debt and equity
securities available for issuance under an effective shelf registration
statement. In addition, the Company has an arrangement enabling it to sell, on
a revolving basis, certain receivables to unrelated third party purchasers. The
agreement is a 364-day facility that is renewable at the option of the
purchasers. The Company may sell up to $70 million of its receivables to these
purchasers in the future and therefore would have immediate access to cash
proceeds from these sales. The amount of the eligible receivables varies during
the year based on seasonality of the business and will at times limit the
amount available to the Company. During the nine month period ended September
30, 2006, there were no receivables sold to third parties under this
agreement.

There have
been no material changes in the Companys financing agreements since December
31, 2005. As described in the Companys 2005 Annual Report, the Company is
party to a number of debt agreements that require it to maintain certain
financial and other covenants, including limitations on indebtedness and an
interest coverage ratio. In addition, under certain circumstances, the
agreements may limit the Companys ability to pay dividends and repurchase
shares of common stock. These limitations are not expected to be a factor in
the Companys dividend and share repurchase plans in the near future. Failure
by the Company to maintain these covenants could result in the acceleration of the
maturity of the debt. At September 30, 2006, the Company was in compliance with
the covenants related to these debt agreements and, based on its operating
outlook for the remainder of 2006, expects to be able to maintain compliance in
the future. The Company does not have any debt agreements that contain put
rights or provide for an acceleration of maturity as a result of a change in
credit rating.

The Company
maintains two lease facilities with banks totaling $68 million which provide
for the acquisition and development of branch properties to be leased by the
Company. At September 30, 2006, there was approximately $68 million funded
under both of these facilities. Approximately $15 million of these leases have
been included on the balance sheet as assets with related debt as of September
30, 2006 and December 31, 2005. The balance of the funded amount has been
treated as operating leases. Approximately $15 million of the available
facility expires in January 2008 and the remaining $53 million expires in
September 2009. The Company has guaranteed the residual value of the properties
under the leases up to 82 percent of the fair market value at the commencement
of the lease. At September 30, 2006, the Companys residual value guarantee
related to the leased assets totaled $56 million for which the Company has
recorded the estimated fair value of this guarantee (approximately $0.7
million) in the Consolidated Statements of Financial Position.

The
majority of the Companys fleet and some equipment are leased through operating
leases. The lease terms are non-cancelable for the first twelve-month term, and
then are month-to-month, cancelable at the

28

Companys
option. There are residual value guarantees (ranging from 70 percent to 87
percent depending on the agreement) relative to these vehicles and equipment,
which historically have not resulted in significant net payments to the
lessors. At September 30, 2006, there was approximately $240 million of
residual value relating to the Companys fleet and equipment leases. The fair
value guarantee of the assets under the leases is expected to fully mitigate
the Companys obligations under the agreements. At September 30, 2006 the
Company has recorded the estimated fair value of this guarantee (approximately
$1.1 million) in the Consolidated Statements of Financial Position.

The
Companys 2005 Annual Report included disclosure of the Companys
contractual obligations and commitments as of December 31, 2005. The Company
continues to make the contractually required payments and therefore, the 2006
obligations and commitments as listed in the December 31, 2005 Annual Report
have been reduced by the required payments. During the third quarter, the
Company signed a marketing agreement that contains future commitments of
approximately $14 million. There were no other significant additions during the
nine months ended September 30, 2006.

Financial PositionReceivables increased from year-end levels, reflecting
normal seasonality, the inclusion of approximately $72 million of InStar
receivables and relatively modest increases in receivables days sales
outstanding at other business units. The InStar receivables include
approximately $13.5 million of hurricane related receivables whose collection
will be significantly delayed, but is ultimately highly probable. Inventories
increased from year-end levels, reflecting general business growth and
increased seasonal activity. Prepaid expenses and other assets increased from
year-end primarily reflecting preseason advertising costs at TruGreen ChemLawn
as well as costs of annual repair and maintenance procedures that are performed
primarily in the first quarter at TruGreen ChemLawn. These costs are deferred
and recognized over the production season and are not deferred beyond the
calendar year end. Deferred customer acquisition costs increased slightly,
reflecting the seasonality in the lawn care operations. In the winter and early
spring, this business sells a series of lawn applications to customers, which
are rendered primarily in March through October. These direct and incremental
selling expenses which relate to successful sales are deferred and recognized
over the production season and are not deferred beyond the calendar year-end.
The Company capitalizes sales commissions and other direct contract acquisition
costs relating to termite baiting and pest contracts, as well as home warranty
agreements. These costs vary with and are directly related to a new sale, and are amortized over its initial term.

Property and
equipment increased from year-end levels primarily reflecting the InStar
acquisition as well as general business growth. The Company does not have any
material capital commitments at this time.

The increase
in accounts payable from year-end levels reflects the acquisition of InStar as
well as seasonality and growth at several of the business units. Deferred
revenue increased from year-end levels, reflecting growth in warranty contracts
written at American Home Shield, an increase in the amount of pest control
customer prepayments partially offset by a decrease from year-end 2005 levels
in customer prepayment balances for lawn care services. Payroll and related
expenses have decreased from year end levels reflecting incentive compensation
payments related to 2005 performance that had been accrued at year-end and paid
in 2006 as well as lower incentive compensation accruals through September 30,
2006 compared to the prior year.

The Company
has minority investors in Terminix. This minority ownership reflects an
interest issued to the former owners of the Allied Bruce Terminix Companies in
connection with the acquisition of that entity. At any time, the former owners
may convert this equity security into eight million ServiceMaster common
shares. The ServiceMaster shares are included in the shares used for the
calculation of diluted earnings per share whenever their inclusion has a
dilutive impact. ServiceMaster has the ability to require conversion of the
security into ServiceMaster common shares, provided the closing share price of
ServiceMasters common stock has averaged at least $15 per share for 40
consecutive trading days.

29

Total
shareholders equity was approximately $1.0 billion at September 30, 2006,
slightly less than the balance at December 31, 2005. The slight decrease
reflects operating profits in the business offset by the first quarter
impairment loss on certain ARS/AMS properties held pending sale, cash dividend
payments and share repurchases.

Under federal
tax rules, dividends are considered taxable only when paid out of current or
accumulated earnings and profits as defined under federal tax laws. As a result
of its December 1997 reincorporation, the Company only began generating
corporate earnings and profits for tax purposes in 1998. Since 1998, earnings
and profits for tax purposes have been reduced by dividend payments,
amortization of intangible assets for tax reporting, deductions relating to
business closures and the timing of certain other tax-related items. The
Company currently expects that less than five percent of its 2006 dividends on
common stock will be taxable as dividend income for federal income tax
purposes. This is lower than the 2005 dividend taxability of 87 percent,
primarily due to one-time effects of the dispositions of American Residential
Services and American Mechanical Services. The 2006 estimate is lower than
previously disclosed due to the disposition effect noted above and a reduced
level of expected earnings for 2006. Any portion of the dividend that is not
taxable would be treated as a return of capital and would generally be applied
to reduce the cost basis of the shares.

DISCONTINUED
OPERATIONS

Revenues for
the third quarter from the combined American Residential Services (ARS) and
American Mechanical Services (AMS) businesses, which were sold during the third
quarter of 2006, totaled $141 million in 2006 and $208 million in 2005. For the
nine months, revenues were $519 million in 2006 and $570 million in 2005. The
decline in revenue was impacted in part by the sale of AMS part way through the
third quarter (in July) of 2006. During the first quarter of 2006, the Company
recorded a ($25) million after-tax impairment charge for expected losses on the
disposition of certain ARS/AMS properties held pending for sale. Related to the sales of the ARS and AMS businesses,
the Company recorded an after-tax net loss of ($.7) million.

The
assets and liabilities related to discontinued operations have been classified
in separate captions in the Condensed Consolidated Statements of Financial
Position. The assets and liabilities of discontinued operations have declined
from year-end levels resulting from the sales of the ARS and AMS businesses.

As part
of the ARS and AMS sale agreements, the Company guaranteed third parties with
respect to bonds (primarily performance and license type), operating leases for
which the Company has been released as being the primary obligor, real estate
leased and operated by buyers, and other guarantees of payment. At the present
time, the Company does not believe it is probable that the buyers will default
on their obligations subject to guarantee. The fair value of the Companys
obligations related to these guarantees is not significant. Accordingly, no
liability has been recorded related to these guarantees.

30

Forward-Looking StatementsThe
Companys Form 10-Q filing contains or incorporates by reference statements
concerning futureresults and other matters
that may be deemed to be forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. The Company intends that
these forward-looking statements, which look forward in time and include
everything other than historical information, be subject to the safe harbors
created by such legislation. The Company notes that these forward-looking
statements involve risks and uncertainties that could affect its results of
operations, financial condition or cash flows. Factors that could cause
actual results to differ materially from those expressed or implied in a
forward-looking statement include the following (among others): the successful
transition of a new Chairman and CEO; the successful consolidation of
headquarters in Memphis; weather conditions that affect the demand for the
Companys services; changes in the source and intensity of competition in the
markets served by the Company; labor shortages or increases in wage rates;
unexpected increases in operating costs, such as higher insurance premiums,
self insurance and health care claim costs; higher fuel prices; changes in the
types or mix of the Companys service offerings or products; increased
governmental regulation, including telemarketing and environmental
restrictions; general economic conditions in the United States, especially as
they may affect home sales or consumer spending levels; time, expenses and cash
flows associated with integrating, selling, or winding down businesses; and
other factors described from time to time in documents filed by the Company
with the Securities and Exchange Commission.

31

QUANTITATIVE AND
QUALITATIVE DISCLOSURES
ABOUT MARKET RISK

The
economy and its impact on discretionary consumer spending, labor wages, fuel
prices, self-insurance and insurance costs and medical inflation rates could be
significant to future operating earnings.

The Company does not hold or
issue financial instruments for trading or speculative purposes. The Company
has entered into specific financial arrangements, primarily fuel hedges, in the
normal course of business to manage certain market risks, with a policy of
matching positions and limiting the terms of contracts to relatively short
durations. The effect of derivative financial instrument transactions is not
material to the Companys financial statements.

In
December 2003 and January 2004, the Company entered into interest rate swap
agreements with a total notional amount of $165 million. Under the terms of
these agreements, the Company pays a floating rate of interest (based on a
specified spread over six-month LIBOR) on the notional amount and the Company
receives a fixed rate of interest at 7.88 percent on the notional
amount. The impact of these swap transactions was to convert $165 million
of the Companys debt from a fixed rate of 7.88 percent to a variable rate
based on LIBOR (9.0 percent average rate during the nine months ended September
30, 2006).

The Company believes its
exposure to interest rate fluctuations, when viewed on both a gross and net
basis, is not material to its overall results of operations. On a gross basis,
the Companys adverse exposure to rising interest rates principally relates to
interest payments on floating rate debt ($393 million at September 30, 2006)
and payments on operating leases that are tied to floating interest rates.
These operating leases consist of approximately $68 million of funding
outstanding under the Companys real estate operating lease facilities as well
as fleet and equipment operating leases (approximately $240 million in residual
value). The Companys exposure to interest expense based on floating rates is
partially offset on a net basis by floating rate investment income earned on
its cash and marketable securities balances. The Company estimates that on a
net basis, each one percentage point change in interest rates would result in a
change of less than $.01 in earnings per share on an annual basis.

The
Company has several debt and lease agreements where the interest rate or rent
payable under the agreements automatically adjusts based on changes in the
Companys credit ratings. While the Company is not currently expecting a change
in its credit ratings, based on amounts outstanding at September 30, 2006, a
one rating category improvement in the Companys credit ratings would reduce
pretax annual expense by approximately $0.5 million. A one rating category
reduction in the Companys credit ratings would increase pretax expense on an
annualized basis by approximately $1.1 million.

The
following table summarizes information about the Companys fixed rate debt as
of December 31, 2005, including the principal cash payments and related
weighted-average interest rates by expected maturity dates. The fair-value of
the Companys fixed rate debt was approximately $491 million at December 31,
2005.

Expected Maturity Date

(In
  millions)
  
  2006
  
  2007
  
  2008
  
  2009
  
  2010
  
  There-
  after
  
  TotalFixed rate
  debt
  
  $
  19
  
  $
  61
  
  $
  12
  
  $
  25
  
  $
  8
  
  $
  359
  
  $
  484Avg. rate
  
  
  5.7
  %
  
  7.1
  %
  
  7.1
  %
  
  7.8
  %
  
  7.9
  %
  
  7.5
  %
  
  7.4
  %As previously discussed, the
Company has entered into interest rate swap agreements, the impact of which was
to convert $165 million of the Companys 2009 maturity debt from a fixed rate
of 7.88 percent to a variable rate based on LIBOR.

32

CONTROLS AND
PROCEDURES

The Companys
Chairman and Chief Executive Officer, J. Patrick Spainhour, and the Companys
President and Chief Financial Officer, Ernest J. Mrozek, have evaluated the
Companys disclosure controls and procedures as of the end of the period
covered by this report.

The Companys
disclosure controls and procedures include a roll-up of financial and
non-financial reporting that is consolidated in the principal executive office
of the Company in Downers Grove, Illinois. The reporting process is designed to
ensure that information required to be disclosed by the Company in the reports
that it files with or submits to the Securities and Exchange Commission is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms. Messrs. Spainhour
and Mrozek have concluded that both the design and operation of the Companys
disclosure controls and procedures are effective.

There were no
changes in the Companys internal control over financial reporting that
occurred during the Companys most recent fiscal quarter that have materially
affected, or are reasonably likely to materially affect, the Companys internal
control over financial reporting.

33

PART
II. OTHER INFORMATION

Item 1: Legal Proceedings

On September
29, 2006, the United States Attorneys Office for the Southern District of
Florida (U.S. Attorneys Office) filed an Information against InStar Services
Group, Inc. that charged InStar with two felony counts of violating the Clean
Air Act. InStar and the U.S. Attorneys Office entered into a plea agreement
that was approved by the Court on November 8, 2006. Under the plea agreement,
InStar pled guilty to the two felony counts and the U.S. Attorneys Office
agreed not to file any additional criminal charges in the Southern District of
Florida against InStar. The plea agreement requires InStar to implement an
environmental compliance plan, be placed on probation for a period of up to
five years, pay a fine of $500,000 for each count, and make a contribution of
$2,000,000 to the Florida Environmental Task Force Trust Fund. Under the plea
agreement, the Company has agreed to take all reasonable steps necessary to
ensure the implementation and enforcement of the environmental compliance plan
by InStar.

Since the
conduct of InStar that is the subject of the plea agreement occurred prior to
the Companys acquisition of InStar, the Company is seeking indemnification
from the sellers of InStar for the amount of its damages and expenses including
fines, contributions and attorneys fees up to $5.5 million. The Company
believes that it is clearly entitled to complete indemnification under the
terms of the acquisition agreement.

The Company
believes that any disruption to the InStar business arising from the plea will
not have a material effect on the Companys financial condition or results of
operations.

Item 1A: Risk Factors

In addition to the other
information contained in this Quarterly Report on Form 10-Q, and the factors
presented in Part I, Item 1A. Risk Factors in the Companys Annual Report on
Form 10-K for fiscal year ended December 31, 2005, the following risk factors
should also be considered in evaluating the Company.

Consolidation of Corporate Offices affects financial performance

ServiceMasters future
success and financial performance depends substantially on its ability to
attract and retain skilled employees and senior executive leaders within the
Company. On October 30, 2006, the Company announced that it will consolidate
its corporate headquarters into its operations center in Memphis, Tennessee.
The Companys current headquarters at Downers Grove, Illinois, will be closed
with the transition to Memphis scheduled to be completed by July, 2007.
ServiceMaster could experience difficulty in immediately
filling job vacancies created by employees and executives deciding not to relocate to Memphis, positions within the Company which
could affect ServiceMasters success and financial performance until
replacements are hired and trained.

Compliance with Subsidiary environmental compliance plan could affect financial performance.

The plea agreement entered into
between InStar Services Group, Inc. and the United States Attorneys Office
for the Southern District of Florida will require ongoing monitoring and
compliance by InStar for the next five years, violation of which could
potentially result in further fines, loss of licenses, loss of certain federal
grants and procurement contracts, and possible criminal sanctions. As part of
InStars plea agreement with the Untied States Attorneys Office, InStar has
agreed to implement a comprehensive environmental compliance plan. The
environmental compliance plan requires, among other things, mandatory training
for all InStar employees on the proper identification, handling and management
of hazardous substances, internal monitoring and audits of the compliance plan,
and third-party auditing and reporting of compliance with the plan. If the
compliance plan is not fulfilled and the plea agreement is violated, potential
risks to the Company include additional and substantial fines, expanded
investigation and prosecution by the United States Attorneys Office, loss of
certain key contractor licenses currently held by InStar, loss of federal
grants and procurement contracts for InStar, negative media exposure and damage
to the Companys reputation that could result in loss of business for InStar
and other business units within the Company, and possible criminal sanctions.

34

Item 2: Unregistered Sales of Equity
Securities and Use of Proceeds

Share Repurchases:

In February
2006, the Board of Directors authorized $250 million for share repurchases.
This authorization replaces the unused portion ($30 million at December 31,
2005) from the previous authorization approved in July 2000. The following
table summarizes the Companys share repurchases for the three
months ended September 30, 2006 under its share repurchase authorization.
Decisions relating to any future share repurchases will depend on various
factors such as the Companys commitment to maintain investment grade credit
ratings and other strategic investment opportunities.

Total Number
  of Shares
  Purchased

Average Price
  Paid per
  Share

Total
  Number
  of Shares
  Purchased as
  Part of Publicly
  Announced
  Plan

Approximate
  Dollar Value
  of Shares that
  May Yet be
  Purchased
  Under the
  PlanJuly 1, 2006 through July 30,
2006




$





$
221,000,000August 1, 2006 through August
31, 2006


3,136,200

$
10.81


3,136,200

$
187,000,000September 1, 2006 through
September 30,
  2006


698,700

$
11.47


698,700

$
179,000,000Total


3,834,900

$
10.93


3,834,900Item 6: Exhibits

Exhibit No.

Description of Exhibit31.1

Certification
  of Chief Executive Officer Pursuant to Rule 13a  14(a) or 15d  14(a), as
  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2

Certification
  of Chief Financial Officer Pursuant to Rule 13a  14(a) or 15d  14(a), as
  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1

Certification
  of Chief Executive Officer Pursuant to Section 1350 of Chapter 63 of Title 18
  of the United States Code, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 200232.2

Certification
  of Chief Financial Officer Pursuant to Section 1350 of Chapter 63 of Title 18
  of the United States Code, as adopted pursuant to Section 906 of the
  Sarbanes-Oxley Act of 200235

SIGNATURE

Pursuant to
the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.

Date:
  November 9, 2006THE
  SERVICEMASTER COMPANY(Registrant)By:
/s/ Ernest
  J. MrozekErnest J.
  MrozekPresident
  and Chief Financial Officer36